Preferred Habitat, Taxable/Tax-Exempt Yield Spreads, and Cycles in Property/Liability Insurance

Karlyn Mitchell and Michael D McDade

Journal of Money, Credit and Banking, 1992, vol. 24, issue 4, 528-52

Abstract: Several theories seek to explain the spread between the yields on taxable and tax-exempt bonds of comparable maturity. This paper reconsiders the market segmentation theory by focusing on property and liability insurance companies (PLICs). PLICs can provide evidence on the market segmentation theory both because they are major participants in the market for longer term tax- exempt bonds and because of their industry's pronounced profit cycle, which causes wide variations in PLICs' need fortax shields. If investors have "preferred habitats" as per the market segmentation theory, their preferences should cause PLICs' purchases and sales of tax-exempts to have different impacts on taxable/tax-exempts yield spreads at different maturities. This paper finds strong evidence of market segmentation during the 1972-84 period, when the industry experienced two extremely pronounced cycles, and weaker evidence of market segmentation during the 1959-71 and 1985-89 periods. Copyright 1992 by Ohio State University Press.

Date: 1992
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Persistent link: https://EconPapers.repec.org/RePEc:mcb:jmoncb:v:24:y:1992:i:4:p:528-52

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